Stable outlook for banks says Moody’s

• Despite external funding challenges, growth to remain stable at about 5% in 2017
• Says strong loan growth may put downward pressure on asset quality and liquidity conditions
• Nonperforming loan rations to remain at decade low, Govt. support expected   

Ratings agency Moody’s Investors Service has maintained its stable outlook on Sri Lanka’s banking system, as moderate economic growth and reduced external volatility should keep operating conditions for the country’s banks stable.

“Continued strong loan growth may put downward pressure on asset quality and liquidity conditions, but nonperforming loan (NPL) ratios will remain at low levels,” says Srikanth Vadlamani, a Vice President and Senior Credit Officer at Moody’s.  “We therefore expect a degree of asset quality deterioration consistent with the current credit profiles of Sri Lankan banks,” added Vadlamani.

Moody’s conclusions are contained in its newest report ‘Banking System Outlook - Sri Lanka: Stable Operating Environment Drives Stable Outlook’. The outlook expresses Moody’s expectation of how bank creditworthiness will evolve in Sri Lanka over the next 12-18 months.

Despite external funding challenges, the rating agency expects economic growth to remain stable at about 5.0% in 2017, a marginal improvement over the 4.7% expected in 2016.

The stable outlook on the banking system differs from the negative outlook on the B1 long-term foreign currency issuer rating assigned to the Sri Lankan Government. 

Sri Lanka’s B1 sovereign credit rating outlook was changed to negative from stable on 20 June 2016, driven primarily by the sovereign’s high level of government debt and implementation risks surrounding planned fiscal reforms.

Moody’s expects asset quality will deteriorate as a result of the relatively rapid 16% loan growth year-on-year at end-September 2016, a key driver of which has been growth of construction loans. The weakening in asset quality will come from a generally low 2.9% nonperforming loan ratio for the system at end-September 2016, which are close to the lowest level for the last decade.

Capital levels are also likely to remain largely stable as pressure on liquidity and funding cause loan growth to moderate. Loan-to-deposit ratios have increased to about 91%, close to the peak reached in 2012, driven by the strong loan growth over the last 18 months.

Positively, though, the banks’ profitability will remain stable, with the firm interest rate environment supporting net interest margins. Cost-to-income ratios may also continue to improve, although only marginally, driven by positive operating leverage.

Finally, Government support to banks should remain stable, with the rating agency expecting Government support for individual banks to be forthcoming if needed.

CB backs organic consolidation of banks 

Says minimum capital requirements could encourage 

positive mergers     

Central Bank Governor Dr. Indrajit Coomaraswamy this week was supportive of minimum capital requirements for banks as it would encourage organic consolidation of the industry. 

 The Sri Lankan Government in its 2017 Budget proposed to increase the minimum capital of licensed commercial banks to Rs. 20 billion from Rs. 10 billion and licensed specialised banks to Rs. 7.5 billion from Rs. 5 billion. Enforcement of Basel III capital standards, which is expected by the Central Bank, could also create greater urgency for banks to build capital.  

“While overall the banking system is stable we do feel that there may be too many banks and this would be a way to encourage consolidation in an organic manner,” Dr. Coomaraswamy said, opting for this measure rather than a Government-backed push for bank mergers. 

Under the previous Government, the Central Bank launched a Master Plan for the Consolidation of the Financial Sector but this did not significantly reduce the number of banks, though several mergers were proposed. Presently there are 25 licensed commercial banks and seven licensed specialised banks in Sri Lanka. 

Last week Fitch ratings warned of the 15 domestic banks rated by them, six did not meet this requirement based on reported core capital as at 1H16. Of these six, three do not even meet the existing, lower capital requirements. It also called for capitalisation in the sector to be shored up.

Banks were initially expected to adhere to the current lower minimum capital requirement from 1 January 2016. However, the Central Bank of Sri Lanka granted extensions to some banks to meet this 

requirement by 1 January 2018 with specified interim targets. 

“Fitch is of the view that the reported capital adequacy ratios of banks in Sri Lanka continue to benefit 

from certain exposures that do not attract a capital allocation under local regulations. Fitch has long 

highlighted that capitalisation of major state banks is thin on an adjusted basis. Internal capital 

generation at these banks is constrained by dividends to the Government and they are likely to continue 

to be dependent on the State for core capital infusions,” the agency said in a statement. 

The capitalisation of most non-state banks has also been decreasing amid rapid credit expansion. The sector has not also raised much core capital through capital infusions from shareholders. Fitch believes banks could face challenges in raising capital, particularly as the operating conditions in Sri Lanka remain difficult , as signalled by  the Negative Outlook on the sovereign rating, which was downgraded to ‘B+’ from ‘BB’ in February 2016.